Exchange rate as a shock absorber or a shock propagator in Poland and Slovakia - an approach based on Bayesian SVAR models with common serial correlation

The paper examines whether exchange rates in Poland and Slovakia acted as shock absorbers or rather shock-propagating mechanisms. A set of Bayesian structural VAR models is built for each country that enables us to identify supply, demand, monetary and financial shocks. Identifying restrictions are derived from the extended stochastic macroeconomic model of an open economy. Sample covers quarterly data 1998-2013. After careful consideration of alternative VAR specifications it is demonstrated that overly parsimonious VARs result in an imperfect identification of shocks that distorts the results. Empirical evidence is found that the higher exchange rate flexibility in Poland than in Slovakia contributed to the absorption of shocks. Though financial shocks had stronger influence on the exchange rate in Poland than in Slovakia, especially in the run-up to the crisis, the participation in the ERM II did not protected the Slovak koruna against the strong and excessive appreciation.